You Don't Need Money to Make Money

You often hear people say that "it takes money to make money". Well, as they say in the Gershwin song, "it ain't necessarily so!"

The simple fact is that you do not need to have money to start or build a business.

Consider the business to be an entity separate and distinct from any individual participant or investor (even if you are the only participant). (Of course, this is actually the case from a legal perspective if the business is organized as a corporation or certain other forms of limited liability entities). As noted in last month's column, each participant (co-venturer) makes a contribution to the venture and in return for that is given some form of consideration. However, as we discussed last month, a contribution to the venture may be something other than money. Instead of hard cash, a contribution could be:

An intangible right or asset (such as intellectual property or a contractual right), or

Services (to the business venture or to one of the other participants), or

Access to resources (such as facilities, equipment or personnel).

Let's assume that you have no money available to invest. However, you come up with an "idea" for a new business, or you have some special expertise or talent that would be valuable to a business and extra time on your hands, or you have a facility or equipment that is not being fully utilized, and could be used by a business. Does the lack of funds take you out of the game? Of course not! You form a venture, contribute the "idea," your services, or use of the facilities or equipment to the venture in return for an equity position (percentage ownership of the entity), and find other participants (co-venturers) to contribute hard cash or resources for their percentages of ownership.

Of course, when you bring in co-venturers, you will have to deal with the issue of valuation. The ownership percentage of a particular co-venturer is a function of the value of the contribution made by that co-venturer relative to the value of the contributions of the other co-venturers. How much can you convince your potential co-venturers that your contribution--the idea, your services, or use of your facilities/equipment--is worth? The factors that typically go into valuation are a subject for another time.

Let's go back to intellectual property and contribution of services for a moment. They warrant a bit more detail.

Intellectual property is probably the intangible right/asset that is most often contributed to a venture in lieu of hard cash. It includes such intangible assets as ideas and inventions, know-how or expertise, information and data, works of authorship, and reputation and goodwill. These assets are often protected (exclusive rights established) by patents, trade secrets, copyrights, and trademarks or service marks. By way of example, an intellectual property contribution could be an idea or design for a product or service around which the business venture will be built; or something (an invention, know-how or expertise, marketing concept or business strategy) that provides some competitive advantage (relating to a product, service, or running the business); or goodwill or credibility (with customers, the public or potential investors) based upon your experience and reputation.

A contribution of services in lieu of hard cash is commonly referred to as "sweat equity." There are potential issues with contributions of "sweat" for equity. First of all, you must actually contribute your services to the venture--you can't draw full salary or otherwise be paid full value for your services, and expect to get equity on top of that. There's also an issue of assuming the risk that the services will actually be performed and will actually be of adequate quality. In other words, which comes first? The sweat or the equity? Most businesses insist that the services actually be provided (and done properly) before the right to receive the equity vests. And, if you are the one contributing the sweat there is yet another concern: the IRS may well take the position the equity received in return for your "sweat" is ordinary income, subject to, for example, income tax and the Social Security/self-employment tax regime, and expect you to pay those taxes on what is, in essence, phantom income.

In any event, it's clear that you can make money--startup or build a business--by contributing something other than cash to the venture, such as intellectual property, sweat, or resources. You don't need to have money to make money.